How safe is your safe haven?
Safe havens are not created equal. It pays to know the difference.
March 27, 2003: 1:16 PM EST
By Jeanne Sahadi, CNN/Money Senior Staff Writer

NEW YORK (CNN/Money) - Investors are looking for safe places to stash their 401(k) savings.

In February, according to its monthly survey of approximately 1.5 million 401(k) plans, Hewitt Associates found that virtually 100 percent of the money transferred within the plans went toward one of three types of conservative vehicles: bonds, money markets, and stable value funds.

What's more, investment research firm TrimTabs estimates that in March, bond and hybrid funds both inside and outside of 401(k) plans will receive inflows of $12.9 billion, a number TrimTabs researcher Carl Wittnebert characterized as "huge."

While stable value, money market and bond funds are all considered safe-haven investments when stocks are suffering, they're not all the same. Each carries different advantages and risks.

Stable value offers solid reward, minimum risk

Money market funds in your 401(k), for instance, are not your best bet these days unless you're confused about what to do next and need a temporary place to park your cash, said certified financial planner Steven Kaye, president of the American Economic Financial Planning Group.

Sure, your principal will be preserved, he said, but you're not going to get much in the way of yield -- currently about 1.25 percent, on average. Inflation -- even at the modest rate of the past few years -- will slowly and surely eat away at the value of your money. By the time you retire, money that's been parked long-term in a money market fund is likely to buy much less than you thought.

As for bond funds, the star performers of the past three years, they may not be as safe today as they were at the beginning of the bear market.

Given that interest rates are now at historic lows, there's a good chance they will rise in the not-so-distant future. When that happens, bond funds may become less attractive since the higher the interest rate (or yield), the lower the price. Any losses the manager suffers by selling bonds at a lower price may lower the net asset value, which is essentially the price per fund share. If that happens, your balance will decline.

Stable value funds, meanwhile, are offering better returns than money-market funds for less risk than bond funds. That's because while their underlying portfolios contain a fair number of bonds, their structure insulates them from the interest-rate risks of traditional bond funds.

Here comes the hybrid

These instruments, which can be thought of as hybrids between bond funds and money market funds, earned between 5.5 and 6.3 percent in 2002, according to the Stable Value Investment Association (SVIA). That's probably why stable value funds -- which are only available in tax-deferred vehicles -- have been the primary recipient of transferring monies in 401(k)s for the past few years. They now represent the largest asset class in the Hewitt 401(k) Index, accounting for 28.4 percent of total balances.

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In a stable value fund, your principal is preserved because an insurer, bank or other financial institution has agreed to maintain the net asset value (NAV). (In a bond fund, by contrast, the NAV can vary as interest rates move.) Put another way, any loss or gain to the NAV is absorbed by the insurer or bank, not the investor, said certified financial planner Mari Adam.

Stable value funds in 401(k)s -- which might also be called interest income, principal preservation, or guaranteed interest funds -- invest in guaranteed investment contracts (GICs), which deliver a fixed rate of return, and in high-quality bonds, typically of short- and intermediate-term duration. The interest you earn on the account, while never guaranteed, rarely moves beyond a narrow range within a 12- to 24-month period, said Kelli Hueler, president of Hueler Companies, a stable-value data-research firm.

In terms of expenses, stable value funds in 401(k) plans aren't likely to cost you much more than an index fund, which is the most cost-efficient investment vehicle. The average expense ratio is about 53 basis points (meaning you pay 53 cents a year for every $100 you have invested).

(Technically, stable value investment vehicles in 401(k)s are not mutual funds. They are governed by the Department of Labor, whereas mutual funds are governed by the Securities and Exchange Commission. Recently, mutual fund firms have begun to offer stable value mutual funds for IRA investors -- currently there are seven available. For a look at their pros and cons, read this Morningstar analysis. According to the Wall Street Journal on March 27, the SEC is looking into how stable value mutual funds value their portfolios. The SEC had no comment, but SVIA President Gina Mitchell said stable value options in 401(k)s would not be subject to the SEC inquiry.)

Why not put all your money in stable value?

For all their merits, stable value investments in your 401(k) aren't without risks or potential hassles. Their earnings can be outpaced by inflation, their yields typically lag the market, and they are not entirely immune from a credit blow-up among the issuers of the bonds they hold.

And in some cases (although far fewer than there used to be in 401(k)s), you may be restricted from moving money out of a stable value account at certain times. Just make sure the rules in your plan don't conflict with your needs.

Finally, while stable value investments can be a useful part of any portfolio, they won't give you maximum growth over time. Both stocks and bonds have outperformed them long-term.

Bonds vs. stable value

Once you've decided how much of your portfolio should be in fixed income, the next question to decide is how much to put in bonds and how much in stable value.

American Economic's Kaye doesn't like his clients to put any more than 20 percent of the fixed-income portion of a portfolio in one fund. So, if you want 40 percent of your money in fixed income, he wouldn't recommend putting any more than a fifth of that (or 8 percent of your fixed-income money) in a stable value fund.

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That's because he wants to benefit from whichever bond class is performing best. In his model portfolio, he has exposure to short-term Treasurys, short-term high yields, a stable value fund and a total return bond fund. "If there's a rush to quality, Treasurys do well, but my high-yield won't," he said, adding that overall, "I'm getting a good blended yield in the 4- to 4.5 percent range."

Since no one knows when rates will rise and because she still sees some niche opportunities for bond fund managers to take advantage of (for example, in European bonds), financial planner Adam is not recommending that her clients put all their fixed-income money in stable value. "I still feel comfortable using a mix," she said.

If, however, you're feeling very risk averse and want principal preservation with some return, it wouldn't be a bad thing to put much of your fixed-income money into a stable value for now, Adam said. Just remember the less risk you assume long-term, the more important it is for you to save even more than usual to compensate for the lower returns you're likely to get.  Top of page

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